nep-fmk New Economics Papers
on Financial Markets
Issue of 2022‒07‒25
sixteen papers chosen by

  1. The post-COVID stock listing boom By Christine L. Dobridge; Rebecca John; Berardino Palazzo
  2. A model of system-wide stress simulation: market-based finance and the Covid-19 event By di Iasio, Giovanni; Alogoskoufis, Spyridon; Kördel, Simon; Kryczka, Dominika; Nicoletti, Giulio; Vause, Nicholas
  3. Quantitative Easing and Credit Rating Agencies By Nordine Abidi; Matteo Falagiarda; Ixart Miquel-Flores
  4. People Are Less Risk-Averse than Economists Think By Ali Elminejad; Tomas Havranek; Zuzana Irsova
  5. ESG-Valued Portfolio Optimization and Dynamic Asset Pricing By Davide Lauria; W. Brent Lindquist; Stefan Mittnik; Svetlozar T. Rachev
  6. Information Geometry of Risks and Returns By Andrei N. Soklakov
  7. The fractional volatility model and rough volatility By R. Vilela Mendes
  8. Market Risk and Volatility Weighted Historical Simulation After Basel III By Jean-Paul Laurent; Hassan Omidi Firouzi
  9. Gold, Bitcoin, and Portfolio Diversification: Lessons from the Ukrainian War By Kim Oosterlinck; Ariane Reyns; Ariane Szafarz
  10. The Big Tech Lending Model By Lei Liu; Guangli Lu; Wei Xiong
  11. Interest Rates Expectations and Flow Dynamics in High Yield Corporate Debt Mutual funds By Ayelen Banegas; Christopher Finch
  12. Getting to the Core: Inflation Risks Within and Across Asset Classes By Xiang Fang; Yang Liu; Nikolai Roussanov
  13. Sovereign Eurobond Liquidity and Yields By Mr. Daniel C Hardy
  14. Hedging option books using neural-SDE market models By Samuel N. Cohen; Christoph Reisinger; Sheng Wang
  15. Measuring Capital at Risk in the UK banking sector: a microstructural network approach By Covi, Giovanni; Brookes, James; Raja, Charumathi
  16. Meeting Investor Outflows in Czech Bond and Equity Funds: Horizontal or Vertical? By Milan Szabo

  1. By: Christine L. Dobridge; Rebecca John; Berardino Palazzo
    Abstract: In the aftermath of the Covid-19 pandemic, the U.S. equity markets have witnessed a surge in the number of publicly listed companies. Using data for the three major U.S. stock exchanges (AMEX, NYSE, and NASDAQ), we find that the number of publicly traded companies went from 4,144 at the end of August 2020 to 5,301 at the end of December 2021, a staggering increase of about 28 percent.
    Date: 2022–06–17
  2. By: di Iasio, Giovanni; Alogoskoufis, Spyridon; Kördel, Simon; Kryczka, Dominika; Nicoletti, Giulio; Vause, Nicholas
    Abstract: We build a model to simulate how the euro area market-based financial system may function under stress. The core of the model is a set of representative agents reflecting key economic sectors, which interact in asset, funding, and derivatives markets and face solvency and liquidity constraints on their behaviour. We illustrate the model's behaviour in a two-layer approach. In Layer 1 the deterioration in the outlook for the corporate sector triggers portfolio reallocation by the model's agents. Layer 2 adds a rating downgrade shock where a fraction of investment grade corporate bonds is downgraded to high yield, which creates further rebalancing pressure and price movements. The model predicts (i) asset flows (buying and selling of marketable securities) across agents and (ii) balance sheet losses. It also provides quantitative evidence on equilibrium effects of the macroprudential regulation of nonbanks, which we illustrate by varying investment fund cash buffers. JEL Classification: G17, G21, G22, G23
    Keywords: COVID-19, market-based finance, stress testing, systemic risk
    Date: 2022–06
  3. By: Nordine Abidi; Matteo Falagiarda; Ixart Miquel-Flores
    Abstract: This paper investigates the behaviour of credit rating agencies using a natural experiment in monetary policy. We exploit the corporate QE of the Eurosystem and its rating-based specific design which generates exogenous variation in the probability for a bond of becoming eligible for outright purchases. We show that after the launch of the policy, rating activity was concentrated precisely on the territory where the incentives of market participants are expected to be more sensitive to the policy design. Our findings contribute to better assessing the consequences of the explicit reliance on CRAs ratings by central banks when designing monetary policy. They also support the Covid-19 monetary stimulus, and in particular the waiver of private credit rating eligibility requirements applied to recently downgraded issuers.
    Keywords: Credit Rating Agencies; Monetary Policy; Quantitative Easing; eligibility requirement; rating activity; behaviour of credit rating agencies; rating Agency Disclaimer; eligibility frontier; Bonds; Bond ratings; Corporate bonds; Credit ratings; Unconventional monetary policies; Global; Middle East and Central Asia
    Date: 2022–06–03
  4. By: Ali Elminejad (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Tomas Havranek (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic & CEPR); Zuzana Irsova (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: We collect 1,021 estimates from 92 studies that use the consumption Euler equation to measure relative risk aversion and that disentangle it from intertemporal substitution. We show that calibrations of risk aversion are typically larger than estimates thereof. Moreover, reported estimates are typically larger than the underlying risk aversion because of publica- tion bias. After correction for the bias, the literature suggests a mean risk aversion of 1 in economics and 2-7 in finance contexts. The reported estimates are systematically driven by the characteristics of data (frequency, dimension, country, stockholding) and utility (func- tional form, treatment of durables). To obtain these results we use nonlinear techniques to correct for publication bias and Bayesian model averaging techniques to account for model uncertainty.
    Keywords: Euler equation, risk aversion, Epstein-Zin preferences, meta-analysis, publication bias, Bayesian model averaging
    JEL: C83 D81 D90
    Date: 2022–06
  5. By: Davide Lauria; W. Brent Lindquist; Stefan Mittnik; Svetlozar T. Rachev
    Abstract: ESG ratings provide a quantitative measure for socially responsible investment. We present a unified framework for incorporating numeric ESG ratings into dynamic pricing theory. Specifically, we introduce an ESG-valued return that is a linearly constrained transformation of financial return and ESG score. This leads to a more complex portfolio optimization problem in a space governed by reward, risk and ESG score. The framework preserves the traditional risk aversion parameter and introduces an ESG affinity parameter. We apply this framework to develop ESG-valued: portfolio optimization; capital market line; risk measures; option pricing; and the computation of shadow riskless rates.
    Date: 2022–06
  6. By: Andrei N. Soklakov
    Abstract: We often think of hedging and investments as having different, even competing goals. In reality optimal hedging and optimal investments are intimately connected. One person's optimal investment is another's optimal hedge. This follows from a geometric structure formed by probabilistic representations of market views and risk scenarios. Understanding this geometric structure is fundamental to risk recycling (and to product design in general).
    Date: 2022–06
  7. By: R. Vilela Mendes
    Abstract: The question of the volatility roughness is interpreted in the framework of a data-reconstructed fractional volatility model, where volatility is driven by fractional noise. Some examples are worked out and also, using Malliavin calculus for fractional processes, an option pricing equation and its solution are obtained.
    Date: 2022–06
  8. By: Jean-Paul Laurent (PRISM Sorbonne - Pôle de recherche interdisciplinaire en sciences du management - UP1 - Université Paris 1 Panthéon-Sorbonne); Hassan Omidi Firouzi (LABEX Refi - ESCP Europe - Ecole Supérieure de Commerce de Paris)
    Abstract: Regulatory capital requirements for market risk, also known as the Fundamental Review of the Trading Book (FRTB), were disclosed by the Basel Committee on January 2016. This major overhaul of the Basel 2.5 framework challenges risk model specification and backtesting. Given the prevalence of historical simulation approach within large financial institutions, we focus on the Filtered (Volatility Weighted) Historical Simulation (VWHS) approach associated with a EWMA volatility filter. Volatility dynamics is then directed by a single parameter. We discuss how this decay parameter, chosen within a reasonable range, at banks' discretion, impacts capital metrics, backtesting statistics, as prescribed by the Basel Committee, and fouls the regulatory benchmarking of internal risk models. We show a trade-off between the resilience of risk models to periods of turmoil and the magnitude of capital metrics. Under the new regulatory rules, this would favour plain historical simulation, as compared with filtered or volatility weighed historical simulation. Understanding why, might be helpful for regulated banks, regarding the management of their market risk models, and supervisors involved in internal model approval.
    Keywords: Backtesting,Historical Simulation,Market Risk,Fundamental Review of the Trading Book,Basel III,Capital Requirements
    Date: 2022–05–26
  9. By: Kim Oosterlinck; Ariane Reyns; Ariane Szafarz
    Abstract: How do major disruptive events, such as wars, affect the correlations between gold, Bitcoin, and financial assets? We address this question by estimating a dynamic conditional correlation (DCC) model before and during the 2022 Russian invasion of Ukraine. The results show that, after the outbreak of the war, the correlation between gold and stock markets dropped, confirming the diversification potential of gold during crises. The correlation between Bitcoin and oil declined as well. Meanwhile, the gold/Bitcoin correlation slightly decreased. Overall, our preliminary evidence suggests that gold and Bitcoin act as complements—rather than substitutes—for diversification purposes during international crises.
    Keywords: Bitcoin; Gold; Portfolio diversification; 2022 Russian invasion
    JEL: G11 G15 F65 E44
    Date: 2022–06–29
  10. By: Lei Liu; Guangli Lu; Wei Xiong
    Abstract: By comparing uncollateralized business loans made by a big tech lending program with conventional bank loans, we find that big tech loans tend to be smaller and have higher interest rates and that borrowers of big tech loans tend to repay far before maturity and borrow more frequently. These patterns remain for borrowers with access to bank credit. Our findings highlight the big tech lender’s roles in serving borrowers’ short-term liquidity rather than their long-term financing needs. Through this model, big tech lending facilitates credit to borrowers underserved by banks without experiencing more-severe adverse selection or incurring greater risks than banks (even during the COVID-19 crisis).
    JEL: G23
    Date: 2022–06
  11. By: Ayelen Banegas; Christopher Finch
    Abstract: Fixed-income mutual funds saw massive outflows during the onset of the COVID-19 crisis, with funds investing primarily in high yield debt markets experiencing the largest redemptions, as a percentage of assets. In March 2020 alone, high yield bond (HYB) and bank loan (BL) mutual fund withdrawals reached an estimated 4.1 and 13.6 percent of assets under management (AUM), accounting for close to $10.4 and $11.4 billion, respectively. Following interventions from the Federal Reserve that helped restore credit market conditions and brought U.S. interest rates back to new lows, flow dynamics of HYB and BL funds began to diverge substantially.
    Date: 2022–06–17
  12. By: Xiang Fang; Yang Liu; Nikolai Roussanov
    Abstract: Do “real” assets protect against inflation? Core inflation betas of stocks are negative while energy betas are positive; currencies, commodities, and real estate also mostly hedge against energy inflation but not core. These hedging properties are reflected in the prices of inflation risks: only core inflation carries a negative risk premium, and its magnitude is consistent both within and across asset classes, uniquely among macroeconomic risk factors. While high core inflation tends to be followed by low real output, consumption, and dividend payouts, it impacts asset prices through both cash-flow and discount rate channels. The relative contribution of core and energy changes over time, helping explain the time-varying correlation between stock and bond returns. A two-sector New Keynesian model qualitatively accounts for these facts and implies that the changing stock-bond correlation can be attributed to the shifting importance of supply and demand shocks in driving energy inflation over time.
    JEL: E31 E44 E5 F31 G12 G15
    Date: 2022–06
  13. By: Mr. Daniel C Hardy
    Abstract: Market liquidity is of value to both investors and issuers of securities, and is therefore a crucial factor in asset pricing. For the important asset class of Eurobonds, significant feedback from liquidity to pricing is established, and it is shown that bid-ask spreads (a proxy for market liquidity) and yields are closely related to bond characteristics such as issue volume, time to maturity, the inclusion of collective action clauses, and the jurisdiction of issuance. Debt management offices can choose these characteristics in a way that has economically significant and persistent effects on both liquidity and pricing.
    Keywords: Eurobond yields; bid-ask spread; liquidity; debt management; instrument design; Log yield determinant; Eurobond liquidity; market liquidity; debt management office; summary statistics; Bonds; Credit ratings; Collective action clauses; Bond yields; Global
    Date: 2022–05–20
  14. By: Samuel N. Cohen; Christoph Reisinger; Sheng Wang
    Abstract: We study the capability of arbitrage-free neural-SDE market models to yield effective strategies for hedging options. In particular, we derive sensitivity-based and minimum-variance-based hedging strategies using these models and examine their performance when applied to various option portfolios using real-world data. Through backtesting analysis over typical and stressed market periods, we show that neural-SDE market models achieve lower hedging errors than Black--Scholes delta and delta-vega hedging consistently over time, and are less sensitive to the tenor choice of hedging instruments. In addition, hedging using market models leads to similar performance to hedging using Heston models, while the former tends to be more robust during stressed market periods.
    Date: 2022–05
  15. By: Covi, Giovanni (Bank of England); Brookes, James (Bank of England); Raja, Charumathi (Bank of England)
    Abstract: In this paper we construct and analyse the UK banking system’s Global Network of granular exposures which captures roughly 90% of the UK banking system’s total assets for the period 2018 Q1 to 2021 Q4. We thus study the microstructure of UK banking system focusing on the role played by concentration risk and interconnectedness across sectors. We then estimate the quarterly evolution of expected losses (Capital at Risk) for the UK banking sector, and via Monte Carlo simulations the stochastic distribution of UK banks’ losses to study the severity and likelihood of tail-events (Conditional Capital at Risk). In the end, we provide insights on the impact of the Covid-19 pandemic on UK banking system’s loss distribution by decomposing the sources of average and tail risks.
    Keywords: Financial network; systemic risk; stress testing; Covid-19 pandemic.
    JEL: D85 G21 G32 L14
    Date: 2022–05–27
  16. By: Milan Szabo
    Abstract: This paper explores liquidity management practices in Czech open-ended bond and equity funds. I reconstruct cash flows stemming from investors and securities and cash flows related to purchases and sales in portfolios and margin calls to study liquidity transformation and liquidity management in investment funds. I point to multiple factors, such as portfolio illiquidity and current market conditions, that influence the joint behavior between investor redemptions and funds' liquidity management. I then investigate how funds replenished their liquid buffers and show that relaxation of liquidity transformation and more aggressive sales from funds' portfolios are the main channels through which funds rebuild their liquid buffers.
    Keywords: Investment fund, liquidity management, liquidity transformation
    JEL: G11 G23 G30
    Date: 2022–06

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